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We're finally seeing the evidence of QE2 show up in the official numbers. The Monetary Base (the part of the money supply that the Fed controls directly) jumped by $140 billion in the most recent period, and is up about $300 billion since mid-Nov. Virtually all of this increase comes from bank reserves which are sitting idle at the Fed (though they do earn an annual interest rate of 0.25%). The increased reserves, in turn, are what the Fed used to purchase Treasuries.

Despite this new injection of reserves, however, there is no evidence to date of any corresponding increase in the other monetary aggregates. That means that although the Fed has created some $300 billion of bank reserves with a keystroke, the amount of money in the economy continues to grow at a rate that is fully consistent with past growth rates. Conclusion: the Fed has not been printing any more "money" than it has in the past.

As the next chart of M2 shows, it has been growing at a 6% annual rate for the past 16 years, during which time inflation has averaged about 2.4% per year. There was a bulge in M2 during the financial panic, but that has since faded away.

What has happened so far with the Fed's quantitative easing program is this: the Fed has swapped newly-created bank reserves (which are the functional equivalent of T-bills) for Treasury notes, and mortgage-backed securities. This has had the effect of shortening the maturity of the government's debt (a good thing since interest rates are low and the yield curve is steep, but it could prove to be a bad thing if and when interest rates start rising), and it has pumped up the Fed's balance sheet by some $1.4 trillion, but it hasn't pumped up the broader supply of "money" in the economy any more than usual. That's not to say it won't happen, only that so far it hasn't happened. We can therefore conclude that, to date, the banking system has been content to hold more risk-free bank reserves and less of other, more risky securities. Similarly, the world economy has been either unwilling and/or unable to increase aggregate borrowing. Put yet another way, the world has been content to hold the extra reserves the Fed has created.

When the Fed's supply of reserves is equal to the world's demand to hold reserves, than there is no inflationary consequence; that explains why inflation has remained relatively low. But there is no guarantee that the situation won't or can't change in the future. It would not be surprising if Fed weren't able to withdraw all the extra reserves in a timely fashion once the banking system decides it no longer wants those reserves. This is the other shoe that is waiting to drop.